Challenges of financial integration in ASEAN

Reading Time: 6 minutes
AEC
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By Cynthia Ho

Globalisation has become more aggressive over the last couple of decades and has accelerated the integration of economies. However, the increase in international trade, international flow of capital and movement of skilled labour as well as the increased role of multilateral organisations or economic blocs such as WTO, APEC, EU etc. have spurred intensifying debates about this integration.

The common question arising among all countries is how to become well integrated to be able to enjoy benefits from each other and, at the same time, to avoid harming or exploiting local markets.

The Asean Economic Community is one of the regional blocs focusing on integration within the region in order to create a single market and production-based, increased competitiveness with the aim to ultimately integrate the region into the global economy. The ASEAN leaders got together in 2007 and agreed on the ASEAN Economic Community Blueprint at the 13th ASEAN Summit to help facilitate the establishment of the ASEAN Economic Community (AEC) by 2015.

There are five targets which the blue print aims to achieve:

  • Free Trade of Goods
  • Free Trade of Services
  • Free Flow of Skilled Labour
  • Free Flow of Investment
  • Free Flow of Capital

Free Trade of Goods refers to trade liberalisation. Several agreements were signed to promote trade within the region by reducing tariffs, namely on the ASEAN Free Trade Area in 1992. During 2010, major ASEAN countries agreed to introduce a zero tariff on 99 per cent of goods traded within the region, while less developed countries (e.g. Cambodia, Laos, Myanmar and Vietnam) aim to achieve the same goal by 2015. To sustain the effort of building a free trade zone, several other measures have been taken, such as the simplification of rules of origin and customs procedures. The reduction of these compliance costs has had a positive effect on free trade within the region so far.

Free Trade of Services aims to promote the services sector in ASEAN countries and to ensure services are flexible enough to be supplied whenever and wherever needed. Liberalisation of services enhances competitiveness by lowering prices as well as efficiency and productivity by increasing the quality of services, e.g. by transferring know-how. However, as of now local service providers in ASEAN still remain subject to domestic regulations and must respect their countries’ institutional and regulatory environment before venturing into other countries. Financial services liberalisation and integration is another goal that the region wants to achieve. But, in fact, each country still has different frameworks, and any liberalisation will have substantial impact on each country’s domestic financial sector. Therefore, in case of financial services, much greater efforts to streamline regulations are required compared to other service sectors.

Free Flow of Skilled Labor refers to mobility of natural persons who can supply specific skills needed in another country. There are still several debates going on in this area. Some countries still impose a certain control on free flow of skilled labour in order to protect their local labour market. Efforts are still needed to enhance mutual recognition of qualifications and to reduce barriers.

Free Flow of Investment encourages investment cooperation and investment protection. Several efforts have materialised in the 1998 ASEAN Investment Area (AIA) framework agreement of 1987 and the 2009 ASEAN Comprehensive Investment Agreement (ACIA), which both aim to enhance cooperation and to protect foreign investment.

Free Flow of Capital aims to strengthen domestic capital markets and to integrate them into a regional capital market. Individual market authorities have implemented policies and initiatives such as the removal or reduction of domestic and international capital flow controls in order to globalise their individual financial markets.

ASEAN banking integration

Supported by the ASEAN Economic Community Blueprint, ASEAN central governors endorsed the ASEAN Banking Integration Framework (ABIF) on April 7, 2011, to bring economic benefits and enhance financial stability in individual countries and the entire region through multilateral liberalisation by 2015. There are four conditions which need to be met in order to successfully achieve the main goal:

  • Harmonisation of regulation
  • Building of a stable financial infrastructure
  • Providing capacity building for BCLMV (Brunei, Cambodia, Laos, Myanmar and Vietnam)
  • Setting up criteria for ASEAN Qualified Banks to operate in any ASEAN country with a single license

However, there are several debates still ongoing against the conditions signed. Some say the basic outline of integration and benchmarks being used to evaluate the progress should be redefined. Differences between price-based measures and quantity-based measures can generate different results for individual countries and produce biased analysis, critics say.

To know whether banks are ready for integration, the ASEAN Framework Agreement on Services (AFAS) lists four factors to take into consideration, which are cross-border bank flows, consumption abroad, the presence of commercial banks and the movement of people. Currently, the ABIF only restricts commercial presence of qualified banks, but it does not help to develop banks in BCLMV, which remains a major obstacle for a free banking market.

Before imposing any integration rules, the ABIF should consider whether countries are ready to integrate their banking sectors, as financial structures and their stability may widely differ from each other. Cross-border banking will only happen between countries which have a stable politic environment, low corruption, efficient government policies and better legal protection for local and foreign investors. Besides, the level of foreign investor participation is not always similar. It also has to be taken into account – when a country opens to foreign participation – whether domestic banks are able to compete with international banks, and how resilient each country is to global financial volatilities.

The above concerns were raised by a couple of ASEAN banks which feared a negative impact from the euro zone debt crisis and also raised concerns that a regional integration could cause similar problems. Thus, the banks have asked to further asses the benefits of a banking integration and their own cost and risk exposure. However, ASEAN banks also have learnt from European banks, and they now need to apply these lessons to their framework to prevent a same crisis happening within the region. Their long term goal is to strengthen regional growth while, at the same time, to reduce poverty, systematic risk, contagion effects and financial instability. How to maximise opportunities while reducing the risks of banking integration remains the main discussion point among the region’s central bank governors as they are moving forward with the policy originally agreed at the Chiang Mai Initiative Multilateralisation (CMIM) agreement of the ASEAN+3 members, which is a multilateral currency swap agreement between ASEAN and Japan, China and South Korea signed in 2009 to bail out ASEAN countries in case of trouble.

ASEAN integration and the euro zone debt crisis

Further questions arise. Assumed ASEAN banks are eventually reaching integration, what would be the impact from the euro zone debt crisis? Which country in ASEAN is most exposed to the EU’s economic and financial system? Which country in ASEAN is best prepared with big currency reserves and room to manoeuver with its interest rates?

The EU remains an important export market for most ASEAN countries. ASEAN economies such as Singapore, Thailand and Malaysia, which rely heavily on trade, will likely suffer in the event of a euro meltdown. Countries relying on international banking and finance will likely also experience problems. The International Monetary Fund estimated that, during the 2008 global financial crisis, for every one per cent of loan defaults by foreign banks to Asia, domestic banks followed suit, contracting their lending by 0.6 per cent by starving credit to small businesses and exporters.

To find out whether ASEAN is safe from European contagion, certain factors need to be assessed. These are (1) share of exports to the EU against total exports in percentage of GDP, (2) EU banks’ lending to ASEAN as a percentage of a country’s total debt liabilities, (3) foreign exchange reserves as a percentage of GDP and (4) government debts as a percentage of GDP. From those numbers, countries can evaluate how vulnerable their economies are to the euro zone problems.

Singapore as the ASEAN region’s financial center has stronger relationship with European banks, and therefore the impact can be tougher, as financial services represent 12 per cent of the city state’s GDP. Indonesia is considered ambiguous in this situation. The country has limited ties to European banks, but is exposed to high foreign ownership of government bonds, which, in turn, makes the financial system vulnerable to global financial worries triggered by a possible euro zone meltdown. Malaysia has borrowed funds at an approximate value of 20 per cent of its GDP from foreign banks, and foreign ownership of Malaysian government bonds has risen up to 39 per cent in 2011, exposing the system at a higher rate to global volatilities. The Philippines have critical remittances from overseas workers from many regions, which could be seen as a kind of hedge against currency volatilities and could protect the country to a certain extent. Thailand, though having a stronger interaction with the European market, has an economy strong enough and sufficient fiscal steering abilities to weather a storm. Vietnam is suffering from high inflation and is relying heavily on export to and foreign direct investment from the EU. Having learnt from the global crisis in 2008, some of the ASEAN countries such as Indonesia are now focusing on stimulating its domestic consumer market by encouraging domestic spending. In sum, ASEAN currently seems sufficiently positioned at least for a muddle-through scenario in Europe, and a moderate recession in Europe likely would not cause serious hazards.

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Reading Time: 6 minutes

Click to enlarge (© Inside Investor)

By Cynthia Ho

Reading Time: 6 minutes

AEC
Click to enlarge (© Inside Investor)

By Cynthia Ho

Globalisation has become more aggressive over the last couple of decades and has accelerated the integration of economies. However, the increase in international trade, international flow of capital and movement of skilled labour as well as the increased role of multilateral organisations or economic blocs such as WTO, APEC, EU etc. have spurred intensifying debates about this integration.

The common question arising among all countries is how to become well integrated to be able to enjoy benefits from each other and, at the same time, to avoid harming or exploiting local markets.

The Asean Economic Community is one of the regional blocs focusing on integration within the region in order to create a single market and production-based, increased competitiveness with the aim to ultimately integrate the region into the global economy. The ASEAN leaders got together in 2007 and agreed on the ASEAN Economic Community Blueprint at the 13th ASEAN Summit to help facilitate the establishment of the ASEAN Economic Community (AEC) by 2015.

There are five targets which the blue print aims to achieve:

  • Free Trade of Goods
  • Free Trade of Services
  • Free Flow of Skilled Labour
  • Free Flow of Investment
  • Free Flow of Capital

Free Trade of Goods refers to trade liberalisation. Several agreements were signed to promote trade within the region by reducing tariffs, namely on the ASEAN Free Trade Area in 1992. During 2010, major ASEAN countries agreed to introduce a zero tariff on 99 per cent of goods traded within the region, while less developed countries (e.g. Cambodia, Laos, Myanmar and Vietnam) aim to achieve the same goal by 2015. To sustain the effort of building a free trade zone, several other measures have been taken, such as the simplification of rules of origin and customs procedures. The reduction of these compliance costs has had a positive effect on free trade within the region so far.

Free Trade of Services aims to promote the services sector in ASEAN countries and to ensure services are flexible enough to be supplied whenever and wherever needed. Liberalisation of services enhances competitiveness by lowering prices as well as efficiency and productivity by increasing the quality of services, e.g. by transferring know-how. However, as of now local service providers in ASEAN still remain subject to domestic regulations and must respect their countries’ institutional and regulatory environment before venturing into other countries. Financial services liberalisation and integration is another goal that the region wants to achieve. But, in fact, each country still has different frameworks, and any liberalisation will have substantial impact on each country’s domestic financial sector. Therefore, in case of financial services, much greater efforts to streamline regulations are required compared to other service sectors.

Free Flow of Skilled Labor refers to mobility of natural persons who can supply specific skills needed in another country. There are still several debates going on in this area. Some countries still impose a certain control on free flow of skilled labour in order to protect their local labour market. Efforts are still needed to enhance mutual recognition of qualifications and to reduce barriers.

Free Flow of Investment encourages investment cooperation and investment protection. Several efforts have materialised in the 1998 ASEAN Investment Area (AIA) framework agreement of 1987 and the 2009 ASEAN Comprehensive Investment Agreement (ACIA), which both aim to enhance cooperation and to protect foreign investment.

Free Flow of Capital aims to strengthen domestic capital markets and to integrate them into a regional capital market. Individual market authorities have implemented policies and initiatives such as the removal or reduction of domestic and international capital flow controls in order to globalise their individual financial markets.

ASEAN banking integration

Supported by the ASEAN Economic Community Blueprint, ASEAN central governors endorsed the ASEAN Banking Integration Framework (ABIF) on April 7, 2011, to bring economic benefits and enhance financial stability in individual countries and the entire region through multilateral liberalisation by 2015. There are four conditions which need to be met in order to successfully achieve the main goal:

  • Harmonisation of regulation
  • Building of a stable financial infrastructure
  • Providing capacity building for BCLMV (Brunei, Cambodia, Laos, Myanmar and Vietnam)
  • Setting up criteria for ASEAN Qualified Banks to operate in any ASEAN country with a single license

However, there are several debates still ongoing against the conditions signed. Some say the basic outline of integration and benchmarks being used to evaluate the progress should be redefined. Differences between price-based measures and quantity-based measures can generate different results for individual countries and produce biased analysis, critics say.

To know whether banks are ready for integration, the ASEAN Framework Agreement on Services (AFAS) lists four factors to take into consideration, which are cross-border bank flows, consumption abroad, the presence of commercial banks and the movement of people. Currently, the ABIF only restricts commercial presence of qualified banks, but it does not help to develop banks in BCLMV, which remains a major obstacle for a free banking market.

Before imposing any integration rules, the ABIF should consider whether countries are ready to integrate their banking sectors, as financial structures and their stability may widely differ from each other. Cross-border banking will only happen between countries which have a stable politic environment, low corruption, efficient government policies and better legal protection for local and foreign investors. Besides, the level of foreign investor participation is not always similar. It also has to be taken into account – when a country opens to foreign participation – whether domestic banks are able to compete with international banks, and how resilient each country is to global financial volatilities.

The above concerns were raised by a couple of ASEAN banks which feared a negative impact from the euro zone debt crisis and also raised concerns that a regional integration could cause similar problems. Thus, the banks have asked to further asses the benefits of a banking integration and their own cost and risk exposure. However, ASEAN banks also have learnt from European banks, and they now need to apply these lessons to their framework to prevent a same crisis happening within the region. Their long term goal is to strengthen regional growth while, at the same time, to reduce poverty, systematic risk, contagion effects and financial instability. How to maximise opportunities while reducing the risks of banking integration remains the main discussion point among the region’s central bank governors as they are moving forward with the policy originally agreed at the Chiang Mai Initiative Multilateralisation (CMIM) agreement of the ASEAN+3 members, which is a multilateral currency swap agreement between ASEAN and Japan, China and South Korea signed in 2009 to bail out ASEAN countries in case of trouble.

ASEAN integration and the euro zone debt crisis

Further questions arise. Assumed ASEAN banks are eventually reaching integration, what would be the impact from the euro zone debt crisis? Which country in ASEAN is most exposed to the EU’s economic and financial system? Which country in ASEAN is best prepared with big currency reserves and room to manoeuver with its interest rates?

The EU remains an important export market for most ASEAN countries. ASEAN economies such as Singapore, Thailand and Malaysia, which rely heavily on trade, will likely suffer in the event of a euro meltdown. Countries relying on international banking and finance will likely also experience problems. The International Monetary Fund estimated that, during the 2008 global financial crisis, for every one per cent of loan defaults by foreign banks to Asia, domestic banks followed suit, contracting their lending by 0.6 per cent by starving credit to small businesses and exporters.

To find out whether ASEAN is safe from European contagion, certain factors need to be assessed. These are (1) share of exports to the EU against total exports in percentage of GDP, (2) EU banks’ lending to ASEAN as a percentage of a country’s total debt liabilities, (3) foreign exchange reserves as a percentage of GDP and (4) government debts as a percentage of GDP. From those numbers, countries can evaluate how vulnerable their economies are to the euro zone problems.

Singapore as the ASEAN region’s financial center has stronger relationship with European banks, and therefore the impact can be tougher, as financial services represent 12 per cent of the city state’s GDP. Indonesia is considered ambiguous in this situation. The country has limited ties to European banks, but is exposed to high foreign ownership of government bonds, which, in turn, makes the financial system vulnerable to global financial worries triggered by a possible euro zone meltdown. Malaysia has borrowed funds at an approximate value of 20 per cent of its GDP from foreign banks, and foreign ownership of Malaysian government bonds has risen up to 39 per cent in 2011, exposing the system at a higher rate to global volatilities. The Philippines have critical remittances from overseas workers from many regions, which could be seen as a kind of hedge against currency volatilities and could protect the country to a certain extent. Thailand, though having a stronger interaction with the European market, has an economy strong enough and sufficient fiscal steering abilities to weather a storm. Vietnam is suffering from high inflation and is relying heavily on export to and foreign direct investment from the EU. Having learnt from the global crisis in 2008, some of the ASEAN countries such as Indonesia are now focusing on stimulating its domestic consumer market by encouraging domestic spending. In sum, ASEAN currently seems sufficiently positioned at least for a muddle-through scenario in Europe, and a moderate recession in Europe likely would not cause serious hazards.

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